Saudi Arabia: Building bonds

Plans by the Saudi Arabian government to boost public expenditures and invest in the nation’s infrastructure could prompt local companies to step up their own investments. As Islamic financial services expand in the Kingdom, some of these borrowers may well turn to sharia-compliant bonds as a means of finance.

Since late February, King Abdullah has announced two major investment packages aimed at further diversifying the national economy and strengthening social programmes such as state-funded housing, health services and education. Hundreds of billions of dollars are expected to be injected into the economy over the coming decade, which will likely create a steady flow of capital into a wide range of sectors, including construction, utilities, technology and communications.

As local players in these fields turn their attention to new state-funded projects, they may well seek sources of financing to boost their own capabilities. For some companies, the use of sukuk (Islamic bonds) could be a viable alternative to borrowing via conventional debt.

Saudi Arabia’s sukuk market remains relatively undeveloped. In 2009 Saudi sukuk fared better than elsewhere in the Gulf, rising to $3.1bn compared to $1.7bn the previous year. However, the market fell slightly the following year, with just $3bn worth of such instruments issued in 2010.

By comparison, the global sukuk market expanded significantly last year, increasing from about $33.5bn in 2009 to $50.6bn in 2010. Malaysia is by far the biggest player on the global stage, accounting for about 80% of the total value of the sukuk market last year. Saudi Arabia was the third-largest market, after Malaysia and Indonesia.

In terms of the number of issuances, the Kingdom accounted for four out of a total of 195 during 2010. Regional contractor Saudi Binladin Group was responsible for one of these four, issuing a short-term sukuk valued at $186.7m in July of last year. On April 17, the company announced that the bond had been repaid in full.

The Saudi Binladin Group sukuk was unusual in that it was the first short-term Islamic bond floated in the Kingdom. In a statement to announce the repayment, the group said that such short-term issuances had much to offer both to investors and firms looking to raise funds.

“We are very grateful to the Capital Markets Authority and Tadawul for the strong support and guidance provided in introducing such a short-term instrument to the Saudi debt capital markets,” the statement read. “Short-term sukuks have the potential to play a significant role in attracting Saudi investor funds to support key infrastructure projects. It provides an excellent opportunity to both investors seeking good quality investment opportunities and issuers seeking diversified liquidity sources.”

Although short-term sukuk may be a useful addition to local capital markets, so far the Saudi Binladin Group bond is the only one of its type issued in the Kingdom. More recently, Bank Al Jazira floated Saudi Arabia’s first sharia-compliant debt of 2011, closing a $267m offering at the end of March. Local units of HSBC and JPMorgan Chase managed the sale, which generated strong interest in the market and was four times oversubscribed.

Like most of the Islamic bonds offered in the Kingdom, the Al Jazira sukuk is a long-term instrument, with a 10-year maturity. Also, like many such offerings, the bank’s sukuk will not be listed on the stock exchange.

According to Nabil Al Hawshan, Bank Al Jazira’s chief executive, the sukuk – the lender’s first venture into the Islamic bond market – drew interest from across the board, and was far more popular than initial forecasts.

“The success of the issue beat expectations,” he told local media on March 30. “Demand was very big from the private and public sector, banks, insurance companies and investment funds.”

While the Bank Al Jazira sukuk proved popular, and demand for other such issuances could increase as spending from the national investment programme begins to flow into the economy, there have been suggestions that more may need to be done to encourage smaller Saudi firms to use sharia-compliant bonds.

A study conducted by the National Commercial Bank (NCB) earlier this year said that if the Kingdom’s sukuk market is to expand, there needs to be a broader spectrum of Saudi firms looking to Islamic bonds as a way of raising capital to fund their activities, rather than the same few issuers.

“Up until small and medium-sized companies start to tap for sukuk financing, the main players and level of issuances are not expected to drastically change,” the NCB report said.

As the state-backed investment plan goes into effect, smaller firms could indeed turn to Islamic bonds to finance their own expansion. Once funding is in place, given the number of projects in the offing there will be no shortage of opportunities for local players to capitalise on.